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Estimating the Likelihood of Mexican Default from the Market Prices of Brady Bonds

Published online by Cambridge University Press:  06 April 2009

Stijn Claessens  and
George Pennacchi
Stijn Claessens
Affiliation:
The World Bank, 1818 H Street N.W., Washington, B.C. 20433
George Pennacchi
Affiliation:
College of Commerce and Business Administration, University of Illinois at Urbana-Champaign, Champaign, IL 61801.
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Abstract

Market prices of developing country debt reflect investors' views of country repayment capacity as well as other debt-specific factors. To extract a measure of repayment capacity from debt prices, adjustments need to be made to account for: debt values being a concave function of repayment capacity; the specific terms of the debt agreement; and the presence of third-party guarantees. This paper derives a measure of repayment capacity by constructing a pricing model that takes these factors into account. Applying the model to Brady bonds issued by Mexico, we find that estimated repayment capacity often performs differently from the unadjusted bond prices. We demonstrate that other Mexican bonds can be priced fairly accurately on the basis of this repayment capacity measure.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 31 , Issue 1 , March 1996 , pp. 109 - 126
Copyright
Copyright © School of Business Administration, University of Washington 1996

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